Five questions and answers on the capacity market

1. What is the Capacity Market?

The capacity market is a mechanism by which Terna procures capacity through futures contracts awarded through a competitive bidding process. The rules for market operation are defined in the Regulation and related annexes approved by Italian Ministerial Decree of 28 June 2019. Operators of production units (dispatchable and intermittent) as well as of storage units can participate in the tender organised by Terna. The operators of the capacity selected as a result of the tender:

- must offer capacity on the energy and services markets

- have the right to receive an annual fixed premium from Terna

- must repay Terna the difference, if positive, between the price of the electricity realised on the energy and services markets and the strike price defined by ARERA (the Italian Regulatory Authority for Energy, Networks and Environment).

Plants that use fossil fuels and take part in the Capacity Market cannot have emissions exceeding the limits defined in the market operating rules. Capacity market units (demand-side response) and foreign resources with specific obligations and rights may also bid.

2. Why do we need a Capacity Market?

The current thermal generation fleet needs to be renovated, with more modern, less polluting and better performing power plants. In the near future, these units will find themselves operating fewer and fewer hours, essentially in order to cope with the periods of scarce production of intermittent renewables (wind and solar) which are increasingly present. This will entail a reduction in the contribution in terms of energy (MWh) from these plants while, at the same time, a need to guarantee a contribution in terms of power (MW).

In the current market model, based mainly on spot prices, it therefore becomes extremely difficult for operators to plan investments—which by their nature have long-term completion horizons and long-term return on investments—in new and efficient generation capacity, knowing that these plants will be used less and less to cover the "base load" and increasingly to manage "load peaks".

The Capacity Market, as designed, guarantees precisely those long-term price signals, anchored to resource availability, which the system needs in order to guarantee renewal and a better performance, also from environmental point of view, thus enabling a better adaptation to future needs of the system. Only with the Capacity Market it will be possible to trigger the investments needed to realize the coal phase-out envisaged by the draft National Energy and Climate Plan (NECP).

3. How does the Italian Capacity Market work?

Terna procures its capacity through competitive auctions where the bonus awarded to operators (for a one-year delivery period for existing plants, and fifteen years for new plants) is given by the definition of the "marginal price", which is defined by the intersection of the demand curves (defined by Terna according to the adequacy targets set for the Italian electricity system) and the offer (established on the basis of the participation of operators).

4. When will the Capacity Market begin?

The first tenders are scheduled for 6 (delivery date set at 2022) and 11 November 2019 (delivery date set at 2023).

5. Is there a Capacity Market abroad?

At the moment, in addition to Italy, other European countries where the Capacity Market is implemented are Great Britain, Poland, Ireland and France, and it is being implemented in Belgium.

Outside of Europe, this mechanism has already been implemented in some electricity markets in North America and Australia.